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Power hungry China

Analyst presentations can be tedious affairs, often an equal mix of the obvious and the dubious. But one I saw about China’s Five Year Plan’s implications of Australia really had me listening closely. The visiting China-based analyst was showing a slide of the projections of the growth in “low carbon” energy out to 2015. It was startling: 40 gigawatts nuclear power, 63 gw for hydro, 22 gw for gas fired, 48 gw for wind, 50 gw for solar and ….. 260 gw for coal generation. “The coal business is going to be huge for Australia for the next 30 years,” the presenter said. “Carbon emissions in China will be up by 426% by 2020,” he continued. By 2035, China’s use of energy will be more than all Europe’s, Japan’s and America’s current energy use.

China has masked what is happening by using proportions. In the Five year Plan, they say they want to raise non-fossil fuel energy to account for 11.4% of primary energy consumption, up from 9.6%. Energy consumption per unit of GDP is to be cut by 17%. The forest coverage is to be increased.

All very laudable, but it does not take into account the economic growth likely to occur over the next two or three decades. It means higher consumption of energy, which will mostly come from fossil fuels. I am not one of the camp who argues that Australia should do nothing about capping emissions until China and America act. That looks suspiciously like a ‘two wrongs make a right’ argument to me. And besides, even if emissions grow, limiting that growth is better than not doing so.

But with China increasing its fossil fuel consumption by such a quantum, whatever Australia does — and for that matter most of the rest of the world does — will be a sideshow.

If global warming pessimists are right, as well as as making our own cuts, we had better start making preparations for a more dangerous environment.

The other big economic shift acknowledged in the 5 Year Plan is the inevitability of higher labour rates, especially on the East coast. Inflation from China is coming. The Plan forecasts annual wage growth of 20%. Last year it was actually above 30% in many regions, and it is continuing at that rate this year. This is a predictable development in a country going through industrialisation, but it does spell the end of cheap wages in China. The government is building heavily inland in order to shift the industry base to the West to leverage low wage labour there. But that is only a temporary reprieve. China will soon be a medium wage country, and that has big implications for the developed world (as WalMart recently flagged).

It means consumer price inflation is probably coming, which, unlike asset inflation, cannot be ignored by central banks. That in turn means higher interest rates, which for the Australian housing market will be devastating. At least the Australian government will probably have a lot of tax revenue from the commodity boom when it is has to nationalise the banks.

China is a giant, and transforming the Australian economy as the graph above shows. It is also going to transform global energy use, irrespective of what any developed economies do. It will probably also transform consumer prices irrespective of what developed economies do. How can the Fed or European Central Bank set interest rates to suppress inflation when the wage rates are being set in China?

Wages in our supplier’s factories have been increasing at between 20 and 30% for about 3 years. Labour is scarce and feeling able to exert pressure for higher wages and conditions. Add in very high commodity prices and you have high imported inflation. As I’ve posted before our landed costs are now higher than when the dollar was at USD0.80
As I’ve ranted about for awhile current domestic inflation is about 5%. FOB prices out of China are rocketing even faster than our asset speculated fuelled A$. Even if the A$ stabilises at the current high levels, we will import high inflation to add to our own 5%.
As SoN says high interest rates here will not stop it. Housing would be devastated as SoN says but guess what? House prices are not included in the CPI are they!
It is a price we will pay for past mistakes and profligacy. The answers lie back in time.

I like many other contrarian observers note that the ABS CPI (and I have actually done a survey for them….) is hopelessly wrong in terms of measuring real change in price.

There are two broad issues: the use of hedonics and the non-inclusion of consumable items like house prices.

Although the RBA target range is too high, IMO (it should be between 1-2% at best), if they knew that real inflation was in the high single digits, we wouldn’t have the “structurally low interest rate environment”.

China’s impact on the Australian economy has been largely through the iron ore trade not coal. Japan is still far and away our largest coal customer, consuming 4x as much of our burnable dirt than the Chinese.

(Of course this may change in the future, especially if the horrific forecast of a 426% in carbon emissions come to fruition … but that will be a tragedy for the entire world not just Australian non-resource exporters)

The thing that’s been driving the commodities boom isn’t Chinese manufacturing and exports, its the runaway fixed asset investment bubble — primarily apartment buildings. That’s where all our iron ore is going, its not into manufactured items.

By definition a bubble is irrational so there’s no telling how much longer it will run. Real industries such as manufacturing will be hurt by higher commodity prices and higher labour costs, and China will rapidly lose its competitive edge, no matter how much they suppress the Yuan. Bubbles however aren’t bound by the laws of gravity, as long as confidence remains strong and the PBoC keeps feeding it credit.

The problem for Australia is that bubbles rarely deflate gently, they burst messily.

MB Fund

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